What caused the EURUSD pullback?

27 November, 2013

Last week, the surprisingly bullish EURUSD trend line was fully broken. There are reasons to believe it was overwhelmed, considering the ongoing EU economic problems, but not many foresaw the bullish trend to be so abruptly disrupted.

What exactly caused such a sudden shift in the EURUSD valuation? News broke out that the ECB was considering introducing negative deposit rates, if their recent interest rate cut didn’t curb the possibility of deflation and reinvigorate economic growth.

What exactly is a negative deposit rate?

In simple terms, introducing negative deposit rates means that banks would have to pay the ECB to keep their money untouched. It is seen as a way to encourage banks to lend to households and businesses, encouraging economic growth, rather than keeping the money derelict.

What is the likeliness of this happening?

Right now, premature. The ECB has already shocked the markets once this month, with an interest rate decrease. However, the emergence of this new change in policy is a clear sign of intent that the ECB is worried about the EU recovery and are ready to act upon this, if need be.

What is it that the ECB are worried about?

Well, where do we start ?

The threat of possible deflation is a big problem for the ECB. Last month, consumer price index fell to a lowly 0.7%. This was far below the 2% inflation target, and triggered the ECB to drastically cut their interest rates to 0.25%. The latest Consumer Price Index is due out this Friday.

Similarly, the latest EU GDP expanded by only 0.1%. Spain exited recession, but there remains to be doubts regarding this sustainability because it was mainly led by an increased demand in tourists, possibly due to holiday makers avoiding more troublesome parts of the world.

Both France and Italy contracted in the past quarter. There are growing fears that both these two major EU economies are about to re-enter recession. This was further fueled when France’s latest Purchasing Managing Index last Friday, showed contraction.

The latest EU unemployment rate is also due to be released on Friday. The bears were awoken last month when unemployment reached a record high 12.2%. According to the European Commission, EU unemployment will remain at this level for the next two years.

Final thoughts:

Bearing in mind the above, I remain bearish regarding the current EURUSD valuation. In my opinion, the EU is indeed experiencing a fragile recovery, like Draghi has always reminded us. There will be some more bumps along the way. Mario Draghi and the ECB still have a lot of work to do.

However, in reference to what caused the pullback, negative deposit rates will not be introduced imminently. The ECB has only just cut their benchmark interest rates, and they will likely wait at least a few more months before deciding if more guidance is needed.

Saying that, the future introduction of negative deposit rates are not out of the realms of possibility. I just don’t think they could be introduced for at least a couple more months.

Right now, It is very important to focus on Friday’s metric data, including the latest inflation release and EU unemployment rate. This could provide clues as to what the ECB’s next move might be.

Written by Jameel Ahmad, Research Analyst at Blackwell Global.
Follow Jameel on twitter @JameelAhmadFX.

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